Trendspotting
Prioritizing Problems
Plan leakage a lesser concern than participation rates
Withdrawals and other leakage issues should be less of a concern to retirement plan sponsors than other factors, according to a research analyst at Vanguard.
Jean Young, senior research analyst at Vanguard Center for Retirement Research, contends that participation rates pose a much bigger problem overall. “The number of people who aren’t participating in your plan is something sponsors should not overlook,” Young said. “Less than 4% of participants take a withdrawal—not their whole account, just a portion of it. Loans don’t really leak; they’re typically repaid. When they do default, it’s usually a portion of the loan—not the full amount.”
Young added: “However, nearly 30% of eligible employees don’t have any retirement savings at all. Rather than the small amount of plan leakage from people who manage to accumulate some retirement savings, getting these nonparticipants into the plan should be of utmost importance.”
Plan sponsors should be concerned any time participants take loans and withdrawals, she acknowledged, because they’re spending their retirement savings. However, even if participants who take distributions haven’t accumulated enough savings to warrant doing so, the fact is that they still have more savings than those not in the plan. Also, loans and withdrawals provide some financial flexibility if a member of their household loses a job, or the participant is buying a home, paying for college, or covering an emergency medical expense. Even though plan leakage is an issue for sponsors, loans and withdrawals can help participants survive financial shocks—and their availability in plans can help boost participation.
Increasing the plan’s participation rate should be plan sponsors’ most important initiative—especially for those who have yet to switch from voluntary enrollment to automatic enrollment, Young contends. Twenty-four percent of Vanguard-recordkept plans with automatic enrollment have higher participation rates (82%) than those with voluntary enrollment (57%), indicating automatic enrollment is a plan design strategy that sponsors seeking to increase participation should strongly consider.
Her commentary explained that part of what’s driving the plan-leakage concern is the fact that, during the 2007–2009 market downturn, hardship and nonhardship withdrawals rose slightly. However, while loans declined during this period, they’ve recently returned to pre-downturn levels—perhaps because those who cut back during the downturn are now generally doing well enough to warrant an increase in spending.
However, even with the slight increase in loans and withdrawals, the numbers pale in comparison with the percentage of eligible, nonparticipating employees when considering all Vanguard-recordkept DC plans as of December 31, 2010.
Vanguard data showed there were 11.5 loans per 1,000 participants in 2010—up just slightly from 11.3 in 2005. Only one in 10 loans default, typically when people change employers, and even then the default is on a portion of the loan, not the entire amount. It’s important to remember that the presence of loans can solve liquidity constraints; employees who know they can access their cash in a pinch may be more likely to participate in the plan, the commentary said.
According to Vanguard data, 3.7% of participants took a withdrawal in 2010. Although a very small percentage of participants took withdrawals, they are a bigger concern than loans—because most loans are repaid. Withdrawn money is out of the plan and can’t return.
In 2010, approximately one-third of eligible employees were not participating in their company’s retirement plan. —Rebecca Moore
Putting Off Until Tomorrow
Delaying retirement no guarantee of affording retirement
If Baby Boomers and Gen Xers delay their retirement past the age of 65, many of them will still not have adequate income to cover their basic retirement expenses, according to a recent study.
Research from the nonpartisan Employee Benefit Research Institute (EBRI) found that, even if a worker delays his or her retirement age into the 80s, there is still a chance the household will be “at risk” of running short of money in retirement. However, the chance of success for retirement adequacy improves significantly as individuals reach their late 70s and early 80s.
EBRI says a major factor that determines a person’s ability to meet basic expenses and uninsured health-care costs in retirement is whether he continues to participate in a defined contribution retirement plan (such as a 401(k)) after the age of 65. The increase in the percentage of households that are predicted to have adequate retirement income as a result of defined contribution participation varies by several factors (such as retirement age and pre-retirement income level), but this factor makes at least a 10 percentage point difference in the majority of the retirement age/income combinations.
The analysis is based on data from EBRI’s Retirement Security Projection Model (RSPM). Developed in 2003, RSPM provides an assessment of national retirement income prospects. The 2011 version of RSPM adds a new feature that allows households to defer retirement age past age 65 in an attempt to determine whether retirement age deferral is indeed sufficiently valuable to mitigate retirement income adequacy problems for most households (assuming the worker is physically able to continue working and that there continues to be a suitable demand for his or her skills).
According to the model, for those in the lowest income group, only 29.6% of households would have sufficient resources to avoid running short of money in retirement 50% of the time if they retired at age 65; however, this increases to 34.6% if retirement is deferred until age 67, and 46.5% if retirement is deferred until age 69.
The incremental increase in the percentage of households in the lowest pre-retirement income quartile having at least a 50% probability of success levels off for several years (in large part due to the elimination of the delayed retirement credits under Social Security) but then picks up again after age 75. Approximately one-half (49.1 %) of the lowest pre-retirement income quartile households retiring at age 75 would have at least a 50% probability of success, but that increases to 61.7% if retiring at age 80, and 90.2% at age 84.
For the second pre-retirement income quartile, less than a quarter (23.5%) of households would have a 70% probability of adequate income if they retired at age 65. This increases to 36.5% if they keep working to age 69.
For those households in the next-to-highest income group, almost half (49.1%) would have a 70% probability of adequate income if they retired at age 65. This increases to 60.5% if they keep working to age 69.
Three-quarters (75.9%) of households in the highest preretirement income quartile are likely to have adequate income for retirement if they retire at age 65. This increases to 81.1% if they keep working to age 69.
The full report appears in the June 2011 EBRI Issue Brief, “The Impact of Deferring Retirement Age on Retirement Income Adequacy.” —Rebecca Moore
Purchasing Power
Mercer report highlights the “annuity dilemma”
Many employees are hesitant to purchase an annuity, despite their desire for retirement income; however, some of these fears may be well-founded, Mercer says.
Given the choice between a lump-sum distribution and receiving monthly payments for life, most retirees still would opt for a lump sum, according to a recent Mercer report, “Retirement, Risk & Finance Perspective.”
The report outlines three behavioral finance attitudes that may be causing this hesitancy.
1) Fear of leaving money on the table: A premature death could result in monthly payments that, in total, are less than the account balance used to purchase the annuity; a locked-in annuity payment may result in a missed opportunity if the account balance had been maintained during a period of rising markets.
2) Overlooking the risks of volatile markets: Retirees are overconfident in the ability of advisers—or themselves—to manage their investments; potential outcomes may be framed in such a way as to stress the prospect of increased wealth rather than the risk of investment losses.
3) Fixation on the large account balance: Monthly annuity payments may seem undervalued in comparison; account balances seem like they always will generate more retirement income; retirees hope that markets will rebound to make up past losses.
The age at which the individual started saving for retirement may be the deciding factor in whether someone can purchase an annuity that would provide adequate retirement income for the individual’s lifetime, the report notes.
The authors created a scenario for two retirees aged 65: one that started saving at age 30, and the other that started saving at age 35. Each employee contributed the same percentage of pay during the savings period and received employer contributions. The analysis found that, for someone who began saving for retirement at age 30, purchasing an annuity will extend their retirement income for 12 years. Conversely, for someone who didn’t start saving until age 35, purchasing an annuity can shorten the time frame for their savings to last. —Nicole Bliman
Change in Payment
SEC proposes changing definition of qualified clients for performance fees
The Securities and Exchange Commission (SEC) has proposed raising certain dollar thresholds that would need to be met before investment advisers can charge their clients performance fees.
The SEC plans to adjust two dollar amount tests in Rule 205-3 under the Investment Advisers Act of 1940 that permits investment advisers to charge performance-based compensation to “qualified clients.” As the rule reads currently, an adviser is permitted to charge clients performance fees in certain circumstances, including if:
1. The client has at least $750,000 under management with the adviser.
2. The adviser reasonably believes the client has a net worth of more than $1.5 million.
In the proposed rule, the SEC revises the dollar amount tests to account for the effects of inflation; revising the dollar amount tests to $1 million for assets under management and $2 million for net worth. The commission noted the Dodd-Frank Act requires the SEC to issue an order to adjust for inflation these dollar amount thresholds by July 21, 2011, and every five years thereafter. Therefore, the SEC’s proposal also includes amending the rule to provide that it will issue an order every five years adjusting for inflation the assets-under-management and net-worth tests, as mandated by the Dodd-Frank Act.
The SEC also proposed amending the net-worth standard to exclude the value of a person’s primary residence and debt secured by the property from the determination of whether a person meets the net-worth standard. “The value of a person’s residence may have little relevance to an individual’s financial experience and ability to bear the risks of performance-fee arrangements,” the commission wrote.
The SEC also has proposed related amendments to Rule 205-3 that would: Provide the method for calculating future inflation adjustments of the dollar amount tests; and modify the transition provisions of the rule to take into account performance-fee arrangements that were permissible at the time the adviser and client entered into their advisory contract.
The SEC sought public comment on these proposed related rule amendments through June and July. —Alison Cooke Mintzer
Scared To Get Help
White paper claims emotional barriers blocking pursuit of advice
A recent white paper asserts that emotional responses are keeping those in and near retirement from accessing professional investment help.
According to “Understanding the Accidental Investor: Baby Boomers on Retirement,” a white paper by advice provider and registered investment advisory firm Financial Engines, those retirement investors are uncertain about the future, fearful of poverty, not confident in their investing abilities, and distrustful of financial services and insurance firms.
Regardless of the primary emotion, the white paper—based on more than 300 interviews and surveys that Financial Engines conducted between 2008 and 2011—reported that these emotions frequently created barriers that prevented participants from accessing professional help. Many participants who expressed those emotions simply avoided thinking about retirement altogether. Participants who made statements that reflected a fear of poverty frequently engaged in what Financial Engines termed “magical thinking” —telling themselves that everything would work out in the end.
Finally, those who were distrustful of financial services or unconfident about finances frequently turned to family and friends for advice, regardless of their qualifications or experience.
Future “Tense?”
More than half of participants interviewed expressed some form of uncertainty in what the future may bring; nearly half had a fear of poverty in retirement; nearly half were distrustful of the motivations or qualifications of financial services and insurance firms; and more than a third of near-retirees and retirees said that they did not feel confident or knowledgeable when it came to making important financial decisions.
In addition to highlighting the emotions and corresponding behaviors of near-retirees and retirees, Financial Engines identified five common needs that, if met, potentially could help participants overcome these strong emotional barriers. Those needs include:
Help from an Adviser. Many participants said that they wanted to work with a financial professional they could trust to help them create a plan and decide on the appropriate course of action. At the same time, many said they found it difficult to know whom to trust with their life savings, according to the report.
Sponsor Evaluation. According to Financial Engines’ white paper, participants said that having their employer select and monitor independent retirement income providers made them more likely to accept professional retirement help.
Fee Transparency. Many participants demanded clear and easily understood fees. They said that they would not act unless they fully understood the fees associated with a given product or service.
Flexibility. Given the uncertainty of retirement, participants expressed a need to have flexibility and control over their retirement investments. According to the white paper, participants had a high reluctance to be locked into an investment vehicle—especially early in retirement when uncertainties are at their highest.
Safety. Due to fear of significant losses right before or in retirement, many participants wanted investments that lowered investment risk or that could provide a steady and reliable source of income over time, and potentially for life. Many participants desired both, according to the report, and many of the participants also wanted flexibility.
Copies of the “Understanding the Accidental Investor: Baby Boomers on Retirement” white paper are available for download free of charge at www.financialengines.com. —Nevin E. Adams
Status Check
Borzi provides an update of proposed regulations
There are still changes to be made to 408(b)(2), said Assistant Secretary of Labor Phyllis Borzi, speaking in May. Secretary Borzi of the Employee Benefits Security Administration (EBSA) addressed the Department’s work with fee disclosures, lifetime income, electronic disclosure, and the definition of fiduciary at a meeting of the International Foundation.
The regulation concerning investment advice is under examination at the Office of Management and Budget (OMB) and is expected to be released in the next few months, Borzi said.
Fee Disclosure
Borzi then addressed the proposed fee disclosure regulations, both for vendors and advisers to provide to plan sponsors, and for plan sponsors to provide to participants.
“The employer has a very, very strong interest in making sure the fees it pays are as low as possible, because they have to make up the difference [in a defined benefit plan]. In a 401(k), it’s the participants that would have to make up the difference—the fees are almost always passed through,” Borzi said.
The participant disclosure regulation has been finalized and is set to become effective January 1, 2012. The fee disclosure regulation for vendors to provide to plan sponsors has been a slower process, she said. It has not yet gotten to the OMB, but it will in the next few weeks. Once it’s at the OMB, it will take at least 90 days for it to be released.
“One reason we were slow in finalizing this reg was, when it was put out in proposed form, we had a lot of comments from consumer organizations…who were concerned that the plan sponsor would get boxes and boxes of information from the vendor—an information dump—and, particularly, small-plan sponsors would be befuddled. So, proposals were made to make a summary disclosure…It’s taken us a while to work through those comments. Some suggested a single sheet; others said no, it should be more of an index or road map. We’ve made some decisions and that regulation will be going forward to OMB within the next week or two,” she concluded.
Definition of Fiduciary
Borzi said, of the regulations the Department of Labor is involved with currently, the proposed regulation that “would make the definition of fiduciary more consistent with the statute” has stirred the most controversy.
The “artificial” five-part test introduced in 1975 has left plan sponsors and participants exposed, she said. “What we’ve discovered is that, in private practice, people who assumed in writing fiduciary liability, when things went south, the trustees were left alone. So, the DoL ends up going after the small-plan sponsors—and they’re the victims,” she said. “They thought they were getting sound advice. So, this proposal is about accountability, transparency, and reducing conflicts of interest.”
She said the proposal has been very controversial, but EBSA is moving forward on it. “We’re not folding up our tents and going home because we think this is really, really important to employers and participants in the IRA marketplace,” she concluded. The comment period closed on April 12.
Lifetime Income
Borzi also addressed the growing issue of lifetime income needs for plan participants. “One of the virtues of DB plans is that the benefits are distributed in a lifetime income stream. In the 401(k) world, that’s not the case; people get lump sums. If you think about it, that’s probably the biggest sum of money this person has ever gotten in his whole life,” she said. How an individual will manage that money to last through retirement is a relatively new conundrum in the history of retirement planning.
“We’ve been looking at this issue along with the Treasury Department to see what we could do to educate the public about the importance of a lifetime income stream without requiring it,” she said. “The first 300 or so comments we received to our joint request for information were from people accusing us of trying to steal their 401(k) plans. ‘Another government takeover,’ when all we were trying to do was see if there’s something the government can do to help people learn about their choices to ensure security.” She said they have some proposals they are working on, but nothing has been made public yet.
Electronic Communication
Addressing the growing call to allow participant communication to be done electronically, Borzi said she and her boss, Department of Labor Secretary Hilda Solis, have some concerns about this request. The argument people are using is that access to the Internet is more available than ever before, Borzi said. However, she and Solis “don’t necessarily see a connection between access to the Internet and people wanting to get all of their financial info electronically.” The Secretaries are particularly concerned about low-income people or people with disabilities who may not have complete access. —Nicole Bliman
Narcissistic and Loving It
Research finds narcissists embrace their label
Old research says narcissists behave the way they do unknowingly; now, research is coming out that says narcissists know they are narcissists and are perfectly pleased with the label.
A “lack of self-awareness” is often one of the attributes given to narcissists, writes Scott Barry Kaufman, Ph.D., a cognitive scientist and personality psychologist, in The Huffington Post. However, he previewed new research coming out of Washington University in St. Louis that says narcissists are fully aware of their inflated egos.
The researchers analyzed college students for the study. They measured each person’s level of narcissism, how those with high scores perceive themselves, and how they are perceived by others. The study included perceptions of both new acquaintances and old friends. The high-scoring narcissists rated themselves as being more intelligent, physically attractive, likeable, and funny than others. The interesting finding is that the narcissists also viewed themselves as being impulsive, arrogant, and prone to exaggeration—the typically “negative” attributes of narcissism.
Additionally, narcissists were well aware of their reputation as being narcissistic. When asked how others might measure them on their positive traits, the narcissists were able to give more accurate descriptions of themselves—closely matching what other people would say about them.
The researchers then posed the question: How can narcissists maintain their inflated self-image even though they know full well how they are perceived by others?
They came up with a few possible answers:
• Perhaps narcissists cling to their narcissism thinking that others haven’t realized how amazing they really are.
• Narcissists think that everyone is just jealous, so no need to change!
• Maybe they don’t fully understand what it means to be a narcissist. Arrogance is a common result of narcissism; the word means to be “confident without merit,” but perhaps it can be misconstrued to mean “deservedly confident,” i.e., I am confident because I should be!
• They’re aware of the positive and negative qualities of being a narcissist and are simply okay with them.
Psychologists used to think they can cure narcissism by informing a narcissist of the “affliction” but, if that doesn’t bother them, there needs to be another method. The study may have given psychologists a new approach—the new acquaintances were not as bothered by the narcissists as the old friends. This supports the previously accepted notion that narcissists make a great first impression, but it wears away rather quickly and they have a hard time keeping long-term relationships.
The researchers suggest that a better method to “cure” narcissists would be to “emphasize the interpersonal…costs of being seen as narcissistic by others.”
“Narcissists are unlikely to change unless they think changing will benefit the things they desire, such as status and power,” Kaufman concluded. —Nicole Bliman